Money Coach

11:04 am

Tue June 11, 2013

Interest Rates Up: Could Spell Uncertainty For Home Loans, Retirement

I'm Michel Martin and this is TELL ME MORE from NPR News. Coming up, American high school graduation rates are the highest they've been in 40 years, but still, nearly a million students a year drop out. So we'll take a look at what's working and what's not in this area in just a few minutes. But first, we go to matters of personal finance. You might have noticed that interest rates are inching back up. There's talk that the Federal Reserve might be easing up on its efforts to stimulate the economy by keeping interest rates low. If that does happen, and interest rates continue to rise, that affects a lot of people. So we wanted to talk more about this so we've called upon, once again, one of our money coaches, Roben Farzad. He's a contributor to Bloomberg Businessweek and he's with us once again. Welcome back, thanks much for joining us once again.

ROBEN FARZAD: Thank you Michel, how are you?

MARTIN: So what is going on with interest rates?

FARZAD: So you've seen interest rates back up and creep up over the past month or so since Ben Bernanke, the Federal Reserve Chairman, gave testimony where he said that they could taper their unprecedented stimulus. In addition to keeping short-term interest rates near zero, the Federal Reserve has been buying on the order of $85 billion a month of bonds and mortgage securities, and that was never intended to be permanent.

MARTIN: I guess the point being that it would have to end sometimes. But who would be most affected if it were? And would this be a shock to the economy, which we understand is now growing, but not fast enough to absorb all the people who are unemployed, all the people who are still looking, and all the people who've been harmed by, sort of, the troubles in recent years?

FARZAD: Sure. To the extent that interest rates rise, interest rates are embedded in everything. They're baked into everything from home loans, to auto loans, to stock prices, to projects that corporate executives take on for their companies. If the government has to pay more to borrow money over 10 years, then Michel Martin has to pay more, then any person who walks into a home loan office has to pay more. So there's this idea that it would crowd out many people and hurt them in terms of their borrowing costs.

MARTIN: What's the argument in favor of easing off on this stimulus and letting interest rates rise?

FARZAD: Well, it was never intended to be forever. It was an emergency measure, obviously with a lot of the other things that the Federal Reserve has done in the wake of the financial crisis. As I mentioned, they kept short-term rates at zero percent. Now that they noticed that the stock market and the housing market are resurgent, that job market participation might be inching up, even though the unemployment rate is still uncomfortably high. They're realizing that it's time at some point, this is not permanent, to pull back the stimulus a bit. They're not going to take it all away at once, but maybe you'll take 85 billion a month to 65 billion a month, maybe then you take it to $45 billion a month. And then at that point, you have to convey to the world that well, we're doing this gradually and we want to make sure the economy can stand out on its own.

MARTIN: Well, we do understand that the Fed is going to meet later this month. What factors are they likely to evaluate to decide whether to let rates start to go up or not? I mean, you're one of the people who was telling us that, yes, it's true that the housing market is coming back, but a lot of the people buying these homes are investors. So the average homeowner isn't participating in this. I mean, clearly there are, sort of, philosophical questions at work here. But what factors is the Fed likely to consider to decide what to do here?

FARZAD: The Fed looks at unemployment and inflation, obviously. Inflation is under check but unemployment is still naggingly high. But they also, I think, implicitly look at other things. They look at the stock market being, pretty much out of record. They look at housing being not just recovering right now, but being hot in certain markets. You have speculators and investors back and not just that, you have people who relied on interest rates being low for refinancing, so existing homeowners. So it affects everyone out there. I mean, it's the rate that's on the tips of every trader's mouth, on the tips of their tongue, that you have to monitor this thing because it's embedded in every risk asset class in the world.

MARTIN: Obviously how you react to this depends on who you are. You know, are you trying to buy a house? Are you trying to retire? But being as general as you can, are there things that people can do to prepare for this possibility that interest rates might start rising again?

FARZAD: If you're a prospective mortgage holder, you have to ask yourself if you're going to play chicken with this game. You think rates are going to fall back down again and stay on the sidelines and wait for that to happen, or if you think rates are heading higher, it might be a good time to lock in the mortgage that you are eyeing right now. In addition, rising rates, rising bond yields hurt bond investors. I know it sounds opposite to what you would think typically, but you have to look at your bond portfolios and see what the sensitivity would be to rising rates. This is still an open question for the entire economy. How does the economy coming out of this economic calamity deal with more normal interest rates? Ones that are not really set by the Federal Reserves taking on extraordinary policy.

MARTIN: Is there anybody who would benefit from interest rates rising?

FARZAD: Certain people who have been short the market - short-sellers who have betted that interest rates would rise. Certain people who are out there that thought that inflation would be a factor, who invested, maybe, in gold. It's a very tricky question and because it's not all set by the Federal Reserve, it's set by the market, and we don't know. You could play a thousand different scenarios and how the world would react to higher bond yields and that's why this is so vexingly difficult for traders and for homeowners and for investors right now.

MARTIN: It may be a silly question, Roben, but I'm going to ask it anyway, which is, is the Fed open to lobbying? I mean, do people write letters and, you know, bring signs saying, keep the interest rates low 'cause I'm about to buy a house? Does that work?

FARZAD: The Fed is an independent body. It's not open to that kind of jawboning. It's supposed to be nonpartisan, but there are certain things that they pay attention to formally, like unemployment and inflation. And I think, informally, if they see the stock market tank, if they see the bond market tank, maybe they would think twice about doing something like this. But, again, it was never intended to be permanent and the tricky thing is, how do you withdraw it gradually to the extent that it was never intended to be permanent.

MARTIN: At this time next year, what kind of conversation do you think we'll be having about this?

FARZAD: I think we'll be talking about pain in the bond market, frankly. I think that, you know, we're five years into this interest rate policy and sometimes you have to come out of it. I think unemployment is not recovering the way anybody would want it to be recovering. But, you have stock markets at an all-time high, you have housing in certain pockets that's very hot, and the world has to come to terms with a normal U.S. bond market, not one that's being treated under emergency circumstances. And that's the big open question for us.

MARTIN: Roben Farzad is a contributor to Bloomberg Businessweek. We caught up with him in Richmond, Virginia. Roben, thank you.